Is Bob Diamond taking a risky road again?

Friday 17 June 2011 11:33 BST

Barclays' new chief executive Bob Diamond is on the road telling investors he plans to lift the bank return on equity from a currently feeble 7% to an eye-catching 13% in a little over two years. That should be enough to send a cold chill of fear down investors' spines.

Apart from the obligatory nod in the direction of more cost cutting and efficiencies, Diamond says a slice of this improvement will come from a recovery in Barclays' continental European business, particularly Spain, where it has been making losses, and some will come from corporate lending, which should improve as the economy improves.

But the most serious chunk of extra revenue, a meaty £2 billion, is earmarked to come from Barclays Capital, the investment banking division.

It is the easiest thing in the world for banks to increase their return on equity. All they have to do is increase leverage, which in layman's terms means borrowing money, betting with it and keeping the winnings.

It works perfectly till markets turn and the bets go sour, at which point the banks are vulnerable to collapse because they have over-extended themselves and do not have enough of their own money, equity, to absorb the losses which result.

That ought to sound familiar. It is what happened in the credit boom and bust and got us into this mess in the first place. And it is what makes Diamond's blueprint unnerving because we don't know how much of the growth earmarked for Barclays Capital will come from taking on more risk.

Why do bankers do this? Well, according to a letter to FT.com this week, penned by Robert Jenkins, head of Combinatorics Capital in New York but also a past chairman of Foreign and Colonial and the Investment Management Association: "Bankers seek high returns on equity because their incentive arrangements tell them to...their incentive systems tell them to because investors have emphasised return without adequately adjusting for the risk."

Successful investors do not simply look for a high return on equity, "they seek high-risk adjusted returns", Jenkins adds. "If higher ROE comes with higher risk they should apply a discount. Banks with little equity that strive for high returns are clearly riskier than banks with more equity in the mix."

That is why investors should be unnerved by Diamond's plans. To the extent that his growth strategy depends on Barclays Capital taking more risk, then the proper response from investors should be to mark the shares lower.

Homing in on help for High St

One of the dafter things the Government did a few weeks ago was asking TV personality Mary Portas to come up with a plan to save Britain's High Streets. What is she supposed to suggest to solve a deep-seated structural problem?

Britain is over-shopped - we have far more shop space per head in this country than almost anywhere else, including richer nations like Germany. So we have more shop owners fighting over a smaller pie.

And shopping habits have changed. People prefer big retail parks - but whenever a Tesco opens on the edge of town, the High Street dies. The butcher, the florist, the newsagent, the chemist, the convenience store, the electrical retailer, the off-licence, the fishmonger, the shoe shop, and sometimes even the café - they all die. That is the reality in small towns across Britain. The bookie, the deli, the odd quirky specialist shop and the antique dealer may survive - for the moment - but not well enough to pick up the empty space. Banks or building societies don't want it. Wine bars, Costa Coffee outlets and charity shops seem to be the only customers. So there is a lot of boarded-up, unused, decaying space.

This is where the Government has come up with something clever. A lot of that space could be converted into housing, but it does not happen because local planners refuse to recognise the empty shops are never going to be filled so they do not allow change of use.

However, there is now a proposal out for consultation that would allow people to convert shops into housing, without the need to get planning consent from the local authority.

Capital Economics reckons such a move could create 400,000 new homes, be a major step towards alleviating the housing shortage, help the construction industry and smarten up the High Streets.

Let's hope the Government has the courage to follow it through - and the sooner the better.